Free trade, growth and prosperity



Free trade, growth and prosperity

From “The Petition of the Candlemakers”

... We ask you to be so good as to pass a law requiring the closing of all windows, dormers, skylights…through which the light of the sun is wont to enter... since we are suffering from the ruinous competition of a foreign rival ... which is none other than the sun!

Samuelson (1980), Bastiat (1996)

1. Theoretical grounds for (and against) free trade

For more than two centuries, economists - from John Steward Mill (1848) to Bhagwati (2004), have been advocating free trade as a nation’s first best policy. In numerous occasions it has been proven since that superiority of free trade holds irrespectively and leads to improving welfare of all trade participants. The underlying concepts, Adam Smith’s concept of absolute advantages and Ricardo’s concept of comparative advantages remained at centre stage of analysis for international economists ever since.

The concept of comparative advantages asserts that countries always benefit from free trade, even in in cases when one country is more efficient than the other in producing every good. In that case, if a country with absolute disadvantages specializes in productioin of a good at which it is least bad at (i.e., where it has a comparative advantage[1]), three benefits for all coutries will emerge: (i) resources will be fully employed; (ii) resources will be allocated in most efficient industries[2] and (iii) free trade will raise overall output and consumption of all trading partners.

What is even more important, theory further asserts that imposing barriers will eventually make the protectionist country worse off. The losses, as presented in Figure 1, will consist of dark regions showing the net loss to society caused by the existence of the tariff.

As presented on Figure 1, prior to the introducing trade, local supply and demand met at point A. Free trade incresed consumption to QC1, and domestic price fell to Pworld. Although population benefited tremendeously, this policy obviously had hurt domestic producers, and tariffs were imposed. This led to increase in the domestic price to Ptariff. The rise in price induced a rise in domestic output from QS1 to QS2 but domestic consumption fell from QC1 to QC2. This has three main effects on welfare: (1) consumer surplus (green region) becomes smaller (2) producers position improved (yellow region) is made larger. (3) government gained additional tax revenue (blue region). However, the loss to consumers is greater than the gains by producers and the government. This “societal loss” is shown by the two pink triangles, showing also the magnitude of the net gain for society from free trade. In addition, one should keep in mind that all trade barriers create a net loss to the society, and thus export tariffs, import quotas or export quotas will all invoke societal losses.

Three theoretical cases remain where protection might improve economic welfare, but all turn out to be a fallacy. These possibilities comprise cases of: (i) retaliation, (ii) the famous “optimum tariff” argument and (iii) using protection as a correction for most market failures.

The first and one of the most enduring arguments, originating from Torrens (1815), claims that free trade cannot be beneficial unless it was reciprocal. Thus if a trading partner decided to impose protection, the free trade state will lose its export market. and thus its imports would either shrink or would have to be paid using gold reserves. In this case, according to Torrens, “the free trade state should abandon free trade”. However, this has not proved to be the best policy. During the period 1929-1933, the spiral of protectionist measures simply wiped out all trade, leaving all countries much worse off. Deeply engaged in retaliatory devaluations (known as “beggar-thy-neighbor-policies”) these countries obviously aimed at exporting recession to other countries in order to achieve comparative advantages. But this policy turned out to be self-defeating since all other countries were doing the same. The countries pursued then in a “tariff war”, with each country raising its tariffs to restrict imports, thus encouraging import substitutions. Imports did fall, but so did exports, since all countries restricted someone else’s exports. Everyone’s fall in exports (as depicted in Figure 2 and originating from the famous textbook by Kindleberger, (1983)), only deepened domestic recession. As presented, retaliation measures proved extremely effective only in creating a complete collapse of international trade.

Although economic history proved Torrens wrong, i.e. that “the free trade state should not abandon free trade”, this lesson - that retaliation measures can well work against its creator - is still not fully accepted. Obviously, countries faced with profit opportunities from protection, or trying to retaliate, find themselves trapped in Prisoners dilemma, failing to realize the existence of the superior, cooperative, free trade outcome. This can help to explain the need for an international supervising body like the World Trade Organization, aiming at preventing from increasing protectionism or retaliatory measures from other countries. Namely, since it is the lack of cooperation which makes it difficult for the countries to realize the superior free trade outcome, the role of WTO is precisely in driving the countries closer towards Nash equilibrium in free trade, for the benefit all countries. Devaluations also seem to be a powerful instrument to increasing competitiveness and net gains from trade, which makes exports rise and imports to fall, due to rising import prices when nominated in of domestic currency. But being a “beggar-thy-neighbor” kind of policy, a country which enacts it can expect retaliations. One of the reasons for making the European Union from the start was precisely this one – to avoid a possibility of countries making devaluations against each other. All monetary arrangements made were exactly aimed at keeping fixed parity of one currency against another, until the moment when all countries adopted just one currency and hence solved this problem forever.

The famous “optimum tariff argument” is another theoretical possibility in which free trade might not not necessarily the best policy of a country, providing a country was large enough in the world markets. This situation occurs when markets fail to work well, and thus prices stop to reflect "true" or social costs. In that case, namely, a country has monopoly in a production of a good and indeed, a possibility arises to use an "optimum" tariff and, thus, gain more from trade. However, as Bhagwati (2001) put it, “this is, of course, the same as saying that a monopolist will maximize his profits by raising his price and reducing his output.” Two objections stem from this argument. First, apart from the OPEC, few countries have monopoly power in enough goods to turn this case into a relevant exception to the rule of free trade. Second, other countries might retaliate against the optimum tariff, like it happened in case of the Smoot-Hawley tariff Act, which was passed in the US in 1930, raising tariffs to an average rate of 60% on many products imported into the US. But in response to diminishing their exports, some 60 foreign nations retaliated and raised their tariffs on imports from the US. Although one could argue that 60% tariff rates might be far from their optimum level, the conclusion would probably remain pretty much the same: the likelihood of successful (i.e., welfare-increasing) exercise of monopoly power becomes quite dubious.

Neither the third argument raised by many economists, that protection might serve as a correction for most market failures, proved to be more than a failure. The reason for this is that the rule must follow the principle that “one cannot kill two birds with one stone.” Thus, instead of healing distortions by imposing protection, the origin of distortion has to be investigated in the first place. In case of domestic distortions, problem has to be solved by a domestic policy, not by protection, if a country wishes to maximize the gains from trade. For example, if wages fail to adjust quickly enough when demand falls (as was the case with U.S. autoworkers losing out to foreign competition from Japan) the appropriate government intervention, if any, should be in the labor market, directly aimed at the source of the problem. Protection would be, at best, an inefficient way of correcting for the market failure. Thus, only in cases where distortions are external, free trade should be departed from, but that brings us back to the Torrens retaliation case.

In short, neither of these three arguments against free trade holds: free trade is always nations best policy, at least for two reasons. The first one is that it is pretty difficult to identify “is there any beef in this hamburger”, i.e. are distortions large enough to be taken into account. Gains from pursuing a policy of optimal departures from free trade in case of industries characterized by imperfect competition were simply not large enough to justify intervention.[3] But in other cases, where some “beef was found” indeed, the argument is that trade intervention in case of imperfect competition in external markets could make things even worse. First of all, this might happen if protection in practice finds itself "captured" by special interests who would misuse it to pursue their own instead pursuing national interest. But any practical value of such arguments for implementing a trade policy may be limited because of rent-seeking or because of directly unproductive profit seeking (DUP)[4] activities that constrain government’s ability to recognize appropriate contexts for trade interventions when and if they exist. Finally, the possibility of “retaliating the retaliator” has always to be born in mind, since this kind of action might then make everyone worse off.

2. Winners and losers from free trade

The moment we allow more production factors enter the stage, the main conclusion will remain – all countries will recored net gains from free trade, but neither will everybody within a country necessarily gain from trade nor will everybody necessarily lose from protection. Thus potential losers from free trade might lobby for intervention, regardless that net gains from free trade remain positive when a country as a whole is concerned. Thus the very identification of losers and winners remains relevant and deserves attention.

But one has to bare in mind that unequal distribution of (undeniably positive) net gains from free trade is quite in line with the theory of international trade! These conclusions stem from traditional general equilibrium theory of international trade, immediately after introducing more than one production factor. [5]

What we get after enlarging Ricardo’s model with another product and another production factor, (which will always be on the opposite sides of any trade policies) are the famous H-O-S (Heckscher-Ohlin-Samuelson) and the Stolper-Samuelson theorem. The HOS theorem states that each country should specialize in producing a good that intensively uses its abundant production factor.[6] If a country is relatively abundant in say, capital, it will be cheaper in production of that capital-intensive good and hence with the opening up of trade it will export its capital-intensive good. In this theoretical framework, an interesting corollary emerges: relative factor prices among countries will equalize. Factor-price equalization (FPE) theorem is the most significant conclusion of the HOS model (but it also is a theorem with least economic evidence so far). Factor prices simply do not seem to consistently converge between trading partners at different levels of development, but the opening era of outsourcing (described in the Annex to this Chapter) might eventually lead to different conclusions.

International trade in goods (from HOS theorem) translates directly into international exchange of factors services, to the Stolper-Samuelson theorem. It states that liberalization raises real incomes of relatively abundant factors in every country, while protection would precicely do the opposite. Thus the theorem reveals how the owners of scarce factors (usually capital in poor countries) raise their incomes gain when protection inhibits imports of competitive products.

However, in a multi-commodity, multi-factor framework, the effectiveness of Stolper Samuelson theorem as means of prediction of losers and winners from protection somewhat diminishes.[7] This gives predominance to the Ricardo-Viner specific—factor rather than to the Heckscher-Ohlin model in identification of policy-relevant interest groups seeking to influence trade policy. Ricardo-Viner model's refers to its distinguishing feature, that a specific factor is ‘stuck’ in an industry, or is immobile between industries in response to changes in market conditions. [8] Finally, as Hilman (1989) shows, industries seek protection, not coalitions or intersectorally mobile factor owners.

And thus we come to the point where it becomes quite obvious that “national interest” or net-gains give little room for politicians to pursue free trade policies, because interest groups would predominantly influence their behaviour. Then another question arises, and this is how would politicians choose as to which interest group to protect. The "new" political economy by Grossman and Helpman (1992), leads us to conclude that politician should equally welcome lobbying dollars of expanding industries as the dollars of declining industries. This is in conflict with the well-noticed asymmetry, i.e. the preponderant share of import protection in declining sectors. This leads to the conclusion that “losers lobby harder”. Cases of industries that have received protection after experiencing increasing import competition are numerous (textiles and clothing, steel, shipbuilding, and automobiles), while counter- examples are rare. The question remains whether government policy picks losers or indeed losers pick governments policy. It is clear that this type of asymmetry is hard to justify from a social welfare point of view, and also, it threatens to halt growth. Still, a sufficient condition for sustainable growth will be that new winners (ex-losers) cannot rest on their laurels because the domestic market will remain contestable and that will enable new entrants! That way, protection will evidently hurt the economy ini the short run, but new entrants would help restoring competition, technological progress and growth.

3. Why are trade barriers so persistent?

Albeit its theoretical superiority, no free trade advocate has ever succeeded in making general public to fully comprehend the advantages of free trade. Two centuries after Adam Smith, politicians prefer to defend “national interests” than the idea of free trade, thus being totally in line with the mercantilist idea of harmfulness of imports (which destroys domestic jobs) over exports (which are good for the economy and employment). Little help comes from the fact that things are just the other way around: it is imports that increase consumption opportunities and exports are just the price to pay for them.[9]

A series of counter-arguments have been offered to prove that free trade was not a superior solution for everyone, and perhaps not even for a nation, but all proved to be invalid. One of the most prominent arguments of this kind since John Stuart Mil was the famous “infant industry argument”, asking for protection of newly established industries. Instead, protection of mature industries seems to prevail (clothing and, shipbuilding, steel, automobiles), proving the thesis that losers, rather than winners, seek and lobby for protection (Baldwin, Nicoud, 2001). Even in cases when it was imposed on export sectors, as in case of the US semi-conductor industry, protection tends to focus on market segments in which domestic industry was losing ground. Thus, infant-industry turned out to be “losers-” and “declining” industry argument instead! Other arguments for protection include the terms of trade argument, arguments concerning corrections in income redistribution, and more recently, strategic trade policy arguments[10]

A series of counter-arguments emerge, indicating bad outcomes of these policies. The most important include the risk of retaliation, the likelihood of incomplete or imperfect information (Bhagwati’s no-beef argument) and the presence of lobbying in a democratic system, as already described in previous paragraphs of this chapter.

Always after curbing protectionism in one place, it turns out live and well in another. Countries even impose protection on goods they do not produce at all, which certainly indicates the existence interest groups of selected importers and their political influence. In this case, classical instrument of protection, like tariffs, do not benefit as much as non-tariff quantitative protection measures, like quotas. The target then is to reach the quantity that enables profit maximization, and monopoly equilibrium (with all its adverse welfare consequences) is than reached through quotas.[11]

Non-tariff barriers need not to be transparent like quotas, but they still are very effective barriers to trade. Hidden barriers of that sort may include the use and abuse of various ostensible or real quality control, health and sanitary control effectively imposing quantitative restrictions. In some cases, abuses of the safeguards of anti-dumping procedures are also used as hidden barrier to import.

New means of protection, frequently came as a replacement for quotas or tariffs, include "voluntary" export restrictions (VERs) or "orderly" market arrangements (OMAs). The protectionist effect remains the same, only this time exporters earn additional profits, too, because the demand for their products remained the same, and the supply fell, due to VERs. Bhagwati (2002) showed how these measures can work against the country that imposes protection. Thus when the US forced Japan to implement VER, the quantity of imported cars fell, and Japanese could (and did) raise prices on their exports to the US. Bhagwati argues that it might be the case that Japanese extra-profits from the voluntary export restraint may also have helped the Japanese car industry to find the funds to make investments that made them yet more competitive! Another anomaly arises with VERs in the eighties, with politics (instead of markets) started to target suppliers, winners, losers and market allocation of goods.

“Administered protection” comes in form of laws that protect a country from foreign competitors who subsidize or impose dumping on their exports. As Morgan Stanley estimates in Tyson (2005), removing China’s explicit and implicit export subsidies would be equivalent to a 16 percent appreciation of the currency against the dollar, which partly explains retaliation that followed, i.e. the urge of the US for China to appreciate its currency.[12]

4. Free trade, growth and poverty

Over the last thirty years (1980-2000) - coinciding a very strong globalization period - the world poverty rate declined from 15.4 to 5.7 percent! This impressive fall in poverty rate, due to a rise in world population, transferred into a 50% decline in poor citizens in the world, form 534 to 211 million.[13] Once widespread and especially Asian phenomenon, poverty seems to have “moved” to Africa, where out of 11 percent of the world population, live 74.5 percent of the world’s poor.

The very process of poverty reduction through trade liberalization seems to have two phases - as first trade acts to promote growth (‘engine of growth’) and then growth reduces poverty.[14]

Figure 4.1 Poverty rates across the world

Poverty rates Regional Poverty Rates ($1.5 a Day Line)

[pic]

Source: Sala-i-Martin (2006), pp. 373 and 380.

But the process is not linear and many difficulties arise during the attempt to make an empirical verification of these steps. An important exception to to rule was found in countries in transition from socialism, in countries with conflicts, and also in coutries dependent on a single natural resource.

Four main benefits of increased trade have been recorded. (1). Growth rates have significantly increased, on average growth rose from below 1.5 percent a year in the 1960s and 3 percent in the 1970s to 3.5 percent in the 1980s and 5.0 percent in the 1990s.[15] (2) No systematic increases in inequality has been recorded. As for inequality, analysts of global income inequality indicate that globalizers reduce inequality faster than any other group of countries. Slower growth in Africa’s per capita income then in the rest of the world widens its income gap, but most authors find that the questions of globalisation can hardly be blamed for that. It is the fact that Africa has been left out of the global economy, while in poor countries who succeeded in engaging themselves in freer trade things went quite differently, whith fascinating results in China and India. As shown on Figure 5 (from Dollar and Kray, 2001), inequality between countries is getting lower, while inequality within countries rise. Another significant rise in inequality is registered in non-globalisers.The concern of immiserising growth, a systematic tendency for inequality to increase when international trade increases, has not been proved. Also, (3) Poverty has declined. As measured by the average income of the poorest fifth of the population, growth of a robust 5.4 percent annually has been recorded. Studies confirm that even in China, where inequality increased sharply, the poorest fifth of the population recorded growth in income at almost 4 percent annually. Experiences of India and China confirm the link between growth and poverty reduction. In India, growth seems to have been instrumental in reducing poverty levels. The proportion of population below the poverty line fell from 50 per cent in late 1970sto 40 per cent in late 1980s and further to 26 per cent in 2000–01 (India Development Report, 2005).

(4) even the gap between the richest and poorest countries has shrinked, but mostly because of the rapid growth of the most populated countries like India China and Bangladesh. The estimates of growth and change in per capita income in 80 countries across the world over the past 40 years shows that incomes of the poor have risen by the same rate as happened to the overall growth.

Still, some authors argue that main conclusions remain questionable, at least for three reasons. First of all, there is no easy way to measure openness, since it is geographical fact rather tha an economic choice of a country: small countries trade more than large ones, and remote countries trade less than countries close to main markets. Second, even if trade policies are taken as a measure of trade liberalization, it is still not clear how to exclude all other measures which might also be responsible for boosting growth. Thus one might have to interpretations on the success of China and Taiwan. Proponents of globalization will thus argue that China and Taiwan achieved growth only after liberalization of their economies, while critics of globalization can insist on the fact that these countries (as well as the Asian “tigers”, South Korea, Hong Kong, Singapore, and Taiwan) simply never stopped with government intervention of remarkable degree, and that such a policy-mix, combined with a variety of initial conditions really makes it very diffictult to judge whether trade or protectionism promoted growth. Anti-globalists frequently stress upon the “fact” that Latin American experience undermines the case for free trade, but this simply is not the case. Chile was the only country in the region to reduce trade barriers to OECD levels, while maintaining macroeconomic stability, a fairly steady annual GDP growth rate of over 5% and fairly low unemployment rate. The rest of the Latin American countries joined this path much later, in late 1980s and in and 1990s, and the important factor underlying this trend was a growing consensus on the role of trade policy in promoting development. But later on, Brazil also started to liberalize, and except for Bolivia and Venezuela, there is no strong domestic opposition to globalisation any more.

The third argument is that the problem causation (does trade initiate growth or it would rather be growth which boosts trade liberalization) is still not resolved. [16] Still, in all trade liberalisation cases a remarkable tendency was observed - that implementation of outward-looking policies tends to establish a "virtuous circle", bringing about further economic and political changes.[17] What happens is that growth of the export sector raises the political strength of exporters and thus increases domestic support for import liberalization of inputs and further for overall liberalisation. Still, this pattern is not universal and the case of Latin America also showed that trends can be reverted.

The debate on causation inevitably rises a question of the problem of bad governance (Washington’s code word for corruption, as Jeffrey Sachs puts it) is a precondition of sucesfull trade liberalisation. And indeed, the problem of the lack of good governance is frequently stated as a prerequisite of free trade policies to result in favorable outcomes. But as Bhagwati (2004) states “the question which must be asked is, not whether freer trade produces significant improvement but whether protectionism would, given the same lack of good governance, produce better results. If you make a comparison of the two policies under identical handicaps, I assure you that it is hard to find convincing reasons to argue for protectionism.”

Such an approach might be helpful in resolving a dilemma stated by Dani Rodrik in The Guardian (December 12, 2005), when he compared the slow growth in Mexico, “which is is fully plugged into the global economy, but yet its economic performance is extremely poor”, with the case of Vietnam, who was under US trade embargo until 1997 and under trade restrictions for many more years and it is not even a member of the WTO. If trade free-trade theorists were right, Rodrik asserts that “Mexico should be streets ahead of Vietnam. In fact, the opposite is true...”, because Mexico hardly growth faster than 1% per annum, while Vietnam has maintained annual growth of 5 percent for the past two decades. Poverty in Vietnam also fell, while real wages in Mexico recorded a fall. But that the case of Vietnam was not a “miracle of protectionism” at all.[18] Vietnam ideed continuously relaxed import and export controls, then it discontinued licences and replaced them with tariffs, and by 1995, lifted export quotas on all (except rice), limiting import quotas to several items. Further steps were taken to liberalise foreign investment throughout the 1990s. The growth rate of exports of goods and services was truly impressive: 28% during 1991-2001.

The case of Serbia under the UN trade embargo can provide further explanation of the mechanism of how trade embargo destroys foreign trade flows. As presented, a dramatic fall in imports presents fatal obstacle to resume export and GDP growth in an import dependent economy. But on the other hand, lifting the embargo tremendously helps in resuming growth, even if no dramatic inner reforms are implemented. Hence part of Vietnamese growth can be attributed to lifting the embargo, also, which would be a one-time success were all abovemetioned measures not implemented! This is particularily difficult, because during the embargo political economy of growth changes, since import lobbists gain crucial power in the country, which can prove fatal for further growth. After lifting the embargo, the country has to find a way to impose macroeconomic stability, good governance, and to impose the economy to freer trade, to introduce competitive exchange rate, etc. This was obviously achieved in Vietnam, and in case of Serbia radical improvements emerged only after democratic changes from end-2000 (gray surface on Figure 6). But in the case of Serbia, growth in exports increased only after dramatic trade liberalisation, and especially after further encouraging the FDIs through introducing more competitive business environment, after enabling privatisation of urban land, harmonizing laws with the EU, etc.

Returning to the case of Mexico, it is really striking that the economic growth reallhy was far higher during the import-substitution than it during the post-liberalisation phase. In the pre-liberalisation period growth rate was over 6 percent, while since liberalisation took place it went to under 3 percent: thus the process of liberalisation coincides with growth deterioration of approximately one-half. This was obviously quite in contrast with the promises of policy-makers and acacemics who envisaged that NAFTA negotiations would boost the Mexican economy especially in terms of improved export performance and growth of living standards.[19] But as Bhagwati and Panagariya insist on, it would be necessary that Mr. Rodrik’s to advice Mexico to close to flow of goods, and FDIs and to put a ban on labour emigration, if the adverse movements in the other economies were explanatory factors for their later success. What is ommited in Rodrik’s analysis is that low or declining trade barriers are not a sufficient condition for rapid growth. Once taking this factor into account, slow growth in Mexico and rapid growth in Vietnam and Serbia after lifting UN embargo (and both still not being members of the WTO) becomes easier to understand.

Evidences from most poor countries confirm that these couontries suffer from poor leadership, ambivalent policies and major institutional defects (corruption, weak legal framework, poor enforcement of contracts, etc.). Thus many times poor results cannot be attributet to lack of results on growth if major defficiences were not taken care of. Else, if the logics of comparison which Mr. Rodrik uses is valid, it would be impossible to explain, for instance, why Sweden for two decades (in mid 1980s and early 1990s) recorded lowest GDP growth rates in OECD, when simply nothing had changed in their trade policies![20] And when compared Swedish case to any other case in the world where some country made changes in its trade policies, we could conclude then anything we like about the effects of trade to growth! Raher than that, one should remember what Sachs and Warner (1995b) concluded “With the...exception of Haiti, - (and Rwanda – DP) there is not a single developing country that had substantially open trade and yet failed to grow by at least 2 percent per year”[21]

The experiences of later reformists, like Ghana, who started radical trade liberalization under the World Bank and IMF guidance, effectively managing pressures for protection by labor unions and domestic import-competing industries and Ivory Coast, who followed a similar path, also show how an outward orientation can can bring poverty alleviation and to reaching a self sustained growth path. It goes without saying, then, that poverty (and inequality in most cases) will also start to diminish.

5. Do developed countries seriously work at alleviating poverty?

5.1. Cacnun negotiations

In spite of all poverty reduction strategies, developed countries are heavily protecting domestic farmers with abundant agricultural subsidies, which are frequently accused to be a hardest obstacle to the poor for becoming succesfull agricultural exporters. But this turns out to be a fallacy, but powerful interest groups remain to back it up. Why is it a fallacy? This is so for two reasons. First, it is not clear that poor, i.e. least developed countries would benefit at all from agricultural liberalization because many of them (as many as 45 LDCs, out of 49) are net food importers; and as many as 33 are net importers of all agricultural products together. After removal of European and American subsidies, LDCs will have to pay more, rather than less for their food, which won’t be very helpful for reducing poverty. What was true of cotton subsidies in the rich countries, because there are four African countries that rely on cotton exports, does not have to hold. …This is the fallacy of using an unrepresentative sample![22] Second, many poor countries themselves for decades were not interested in agricultural development. They identified development with industrialization; and their own trade policies created a substantial bias against agricultural development. Thus, rich countries wanted to protect their agriculture; the poor countries wanted to decimate theirs, and a Faustian bargain resulted, Bhagwati (2005).

But in the case of Mexico, removing agricultural subsidies in the US would be very helpful indeed. The Cairns group (Argentina, Brazil, Mexico, the Philippines, Thailand, New Zealand and Australia) even became a very hard lobbyist for removing these obstacles, and there is no doubt that all those countries would strongly benefit from lifting those subsidies in developed world. The effect on the poorest countries wold be unfavourable, at least at the start, but anyway, that would by no means be a good step if performed carefully and with full awareness of these immediate consequences.

 

Thus one has to face the fact that liberalizing agriculture might even harm many of the least developed countries. But other instrumentalities will have to be implemented to assist them, since this subsidies do not solve the problem.

2. Fallacies in defining trade policies

Ever since Britain abandoned British Corn Laws in 1846, up to recent experiences of Singapore, Hong Kong, Chile, Australia, New Zealand, Indonesia and India, remain practical examples of how powerful trade liberalization can be, even if it remains unilateral, not not many countries seem to be eager to join the queue. To make things even harder, anti-globalisation movements around the world have raised a serious doubt in valitidy of the arguments stated by liberal trade economists.

Four fallacies[23] remain which strongly influence national trade policies and which deserve to be mentioned.

• Freer trade would lower wages in rich countries and protection remains necessary. But as shown in Annex, this is a fallacy. Wage levels are always determined by the productivity, not by a trade policy of a country. What is needed for maintaining high level of wages is that labor moves to more productive uses each time a strong foreign competitor emerges. This is Bhagwati’s “ladder of comparative advantage” which probably speeds up technological progress in leading economies. Losers from mature industries them will form interest groups to fight free trade, claiming to be fighting for “economic patriotism” but fighting for themselves, instead. Nor will immigrants succeed in lowering wages in rich countries, as they have never done this so far. In addition, growth in their own countries (as it started in India, China, Korea, etc) will hold them at home, but they will make a competitive pressure from there, also. This has only led to progress for all so far, with no reason for things to turn the other way around.

• Infant industries in poor countries will collapse unless protected, is another fallacy, which remains vivid despite all examples proving that this is not the case. But autarkic trade barriers seem to make another big distortion, as they create an anti-export bias! As Yeats and Ng (1996) have shown, even when the rich-country markets are opened further, one’s own trade barriers can prevent the penetration of these markets.

• That the rich countries have more trade barriers than the poor ones is another fallacy. The truth is exactly the opposite: poor countries have greater tariff protection on manufactures. The poor countries enjoy Special & Differential Treatment in trade negotiations. As Bhagwati (2004) indicates, few poor countries have undertaken significant commitments on services, nor are developing countries obliged to sign the optional procurement code, which all rich nations have signed.

• Agricultural subsidies in the rich countries prevents the poor from becoming succesfull agricultural exporters, which unfortunately is also a fallacy driven by powerful interest groups, as described in previous paragraph.

5.3. Policy implications and prospects

Being trapped in Prisoners dilemma, the trade diplomats often refer that “concessions” are granted in exchange for an trade opening somewhere else. Under the umbrella of the World Trade Organisation, any concession to one trade partner is automatically extended to all members, which has helped the world enjoy decades of prosperity.

But the future of this central principle of non-discrimination (the Most Favoured Nation principle) which enabled that each trade liberalisation automatically leads to overall trade liberalization has been virtually destroyed by a growing number of PTAs (preferential trade agreements), the number of which proliferated to close to 300. These agreements which the architects of the GATT thought would be minor exceptions have now swallowed up the trading system. All economists now recognize the resulting “spaghetti bowl” problem, as Bhagwati (2000) had christened it. It results in a chaotic crisscrossing of preferences, which apply different trade barriers to same products depending on which countries they originate from. “This is a fool’s way of doing trade—not only does it destroy the efficient allocation of resources, but it flies in the face of the fact that today it is becoming almost impossible to define which product is whose… And evidently, the MFN tariff in the EU has now become the LFN, the least favored nation, tariff! said Bhagwati his 2005 paper.

The way out of this jam is that the only way to “kill” the PTA-generated preferences (which are of course relative to the MFN tariff) is by curbing the MFN tariff itself down to negligible levels. The suggestion is that after concluding the Doha Round another multilateral trade negotiation should follow which will eventually get the MFN tariffs virtually down to zero. The good news here is that an important trading partner, United States, seem to be aspiring this idea.[24]

Another threat to the multilateral trading system arises from the ability of rich-country lobbies to capture the trade liberalization process (through PTAs and S&Ds - special and differential treatment for developing countries) to pursue their own unrelated agendas, such as labor standards, which would then be implemented into trade agreements and institutions such as the WTO. This is nothing but abuse of the WTO, which is, unfortunately, driving things back from freer trade perspective in which the EU administration is specially persistenent.

But evidences are that over the last half century trade has dramatically reduced poverty, so dramatically that even the hardest anti-globalizers do not deny this fact. Growth proved to be the best antidote to poverty and trade proved to be an engine of growth of incomes and generator of new jobs in an economy.

It has to be born in mind, however, that as Adam Smith already said, this process needs time for people to fully comprehend and adopt new rules. But when it comes to free trade, as Adam Smith once said, "Not only the prejudices of the public, but what is much more unconquerable, the private interests of many individuals, irresistibly oppose it”.[25]

References

1. Alesina, Gavazzi (2006) The Future of Europe, Reform or Decline, MIT Press

2. Linda Low, THE POLITICAL ECONOMY OF TRADE LIBERALIZATION, Asia-Pacific Development Journal Vol. 11, No. 1, June 2004

3. David Sapsford, Supriya Garikipati (2006) Trade Liberalisation, Economic Development and Poverty Alleviation The World Economy 29 (11), 1571–1579.

4. Bhagwati (1964) Pure Theory of International Trade

5. Bhagwati (2001) Free Trade Today:, Princeton University Press, 2001

6. Bhagwati (2004) In Defense of Globalization

7. Baldwin, Robert-Nicoud (2004) “Entry and asymmetric lobbying: Why governments pick losers*,

8. Begovic onaj tekst trade liberalization

9. Bhagwati (1994) Free Trade: Old and New Challenges

The Economic Journal, Vol. 104, No. 423 (Mar., 1994), pp. 231-246

doi:10.2307/2234745

10. Hillman Political Economy of Protection (Fundamentals of Pure and Applied Economics Series) (Paperback) by Arye Hillman

11. Baldwin, Robert E. The Political Economy of U.S. Import Policy. 1985.

12. Bhagwati, Jagdish. Protectionism. 1988.

13. Blinder, Alan S. Hard Heads, Soft Hearts: Tough-Minded Economics for a Just Society. 1987.

14. Dixit, Avinash. "How Should the U.S. Respond to Other Countries' Trade Policies?" In U.S. Trade Policies in a Changing World Economy, edited by Robert M. Stern. 1987.

15. Hufbauer, Gary C., Diane T. Berliner, and Kimberly A. Elliott. Trade Protection in the United States: 31 Case Studies. 1986.

16. Lawrence, Robert Z., and Robert E. Litan. Saving Free Trade. 1986.

17.

18. Viner, J (1937) Studies in the Theory of International Trade, NY

19. Torrens, R (1815), Essay on the External Corn Trade, J. Hatchard, London.

20. Blinder, Alan S. Hard Heads, Soft Hearts: Tough-Minded Economics for a Just Society. 1987.

21. Economic Report of the President, 2004)

22. Bastiat, Frederic. Economic Sophisms. Irvington-on-Hudson, NY: The Foundation for Economic Education, Inc., trans. and ed. Arthur Goddard, 1996

23. Samuelson (1990) Economics

24. Mankiw, Swagel (2006) The Politics and Economics of Offshore Outsourcing

25. Samuelson, Paul A., 2004. “Where Ricardo and Mill Rebut and Confirm Arguments of Mainstream Economists Supporting Globalization,” Journal of Economic Perspectives, Vol. 18 No. 3 Summer 2004, pp. 135-146.

26. Clyde and Wada (1999) Steel Quotas: A Rigged Lottery, Peterson Institute

27. John Steward Mill, 1848, Principles of Political Economy.

28. Torrens, Robert (1815), Essay on the External Corn Trade, J. Hatchard, London.

29. Kindleberger (1973) International Economics, MIT Press

30. Tibor Scitovsky, “A Reconsideration of the Theory of Tariffs,” Review of Economic Studies 9 (1942): 89–110;

31. Sodersten, B. (1980) International economics, Mc Graw Hill

32. Hilman, A. (1989) The Political Economy of Protection, Harwood

33. Popovic, D. Teoreme o medjunarodnoj razmeni, BIGZ

34. Gawande, Krishna (2001), The Political Economy of Trade Policy: Empirical Approaches, Working Paper Number: 2001-38

35. Baldwin, Nicoud (2001) Entry and asymmetric lobbying: Why governments pick losers,

36. David R. Henderson Ed, The Concise Encyclopedia of Economics, Liberty Fund, Inc.

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41. Bhagwati (2006a) Globalization and Germany: Wrong Fears and Right Responses, transcript

42. Laura D.Andrea Tyson, Stop Scapegoating China .Before It.s Too Late., Business Week, May 2, 2005).

43. (Sala-i-Martin, 2002)

44. Sala-i-Martin, 2006, The World Distribution of Income: Falling Poverty and . . . Convergence, period*, The Quarterly Journal of Economics, Vol. CXXI May 2006

45. Rachel McCulloch 2000 Unilateral and reciprocal trade reform in latin america

46. UNDP (1999);

47. Dollar and Kray (2001),

48. Bhagwati, Srinivasan (2002);

49. Baldwin (2003);

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51. Winters (2004),

52. Barro and Sala-I-Martin (2004),

53. Aisbett (2004).

54. Dominic M. Ayine Managing trade liberalization: legal system deficiencies and the political economy of contingency protection in Ghana Journal of African Law (2004), 48: 207-238 Published online by Cambridge University Press 08Nov2004

55. Panagariya, (2006). "Free-Trade Skeptics: Wrong Again." Economic Times

56. Bhagwati, (2005) Reshaping the WTO, Far Eastern Economic Review, Jan/Feb 2005

57. Francis Ng and Alexander Yeats, 1996, Open Economies Work Better! Did Africa's Protectionist Policies Cause Its Marginalization in World Trade?, Policy Research Working Papers, World Bank

APENDIX

Not even the best trade policy can compensate for the lack of good leadership, coherent economic policies and major institutional defects (corruption, weak legal framework, poor enforcement of contracts, etc.) Thus beneficial effects of freer trade cannot sometimes be traced from the agle of poor countries. The aim of this Appendix is to provide examples from developed countries and to show that their fears of freer trade often seem to be very similar to the ones in poor countries, and that as in the case of poor countries, interest groups win and countries lose with protectionism.

A1. Free trade and jobs lost: globalisation and outsourcing debate

Joseph Stiglitz, Nobel Prize laureate in economics, defines Globalization as follows: "Globalization is the closer integration of the countries and peoples of the world ... brought about by the enormous reduction of costs of transportation and communication, and the breaking down of artificial barriers to the flows of goods, services, capital, knowledge, and people across borders." (from Globalization and its Discontents). This is a very complex process[26], essentially being nothing but deepening of free trade, but yet and again, this is phenomenon is not a very welcomed one. Many anti-globalization movements across the globe claim that globalization is just another word for a form of “Americanization", claiming that the United States could be one of the few countries (if not the only one) to truly profit from globalization. And within the US, media only too often record complains about cheap Chinese imports that destroy American jobs. Hence the country accused to be the only winner of globalization also experiences harsh competition through new types of trade, such as outsourcing.

A2. Arguments against globalisation: what did Paul Samuelson really say?

According to planetary media coverage from 2004, Paul Samuelson almost gave the final “coup” to advocates of globalisation and free trade, publicly confronting mainstream economic consensus on the long run benefits that American economy will make in all forms of international trade, including the outsourcing of call-center and software programming jobs. That is ''only an innuendo,'' Mr. Samuelson writes. “'For it is dead wrong about necessary surplus of winnings over losings.”

Although Samuelson did not explicitly mention outsourcing and globalization, his article for the Journal of Economic Perspectives (2006) turned out to be a theoretical stick on which traditional doubters could lean on. However, what Samuelson really said was nothing of the kind. He only offered three cases of trade and showed that theoretically one of three possible outcomes is that trade might not bring long-run benefits of free trade for all participants. The three analyzed cases go like this. In case of the United States and China, the first case would be the classical Ricardo’s case, where both countries have a comparative advantage in one good, with a well-known outcome where both nations gain from free trade. In the second case, China improves its productivity gain in its export good; both countries gain from free trade again, improving also the U.S. terms of trade and bringing further benefits to the consumers in the United States. A third case (act two, as Samuelson put it) turns out to be problematic, and that is when China (through an innovation) improves productivity in its import-competing sector, and this improvement turns out to be “large enough to cut some U.S. production of it”. Only in that case, Chinese technological improvements would “blow away all of the United States’ previous enjoyments from free trade.”

However, the fact remains that Samuelson’s “Act II”, although theoretically possible, remains highly improbable. Samuelson confirmed that himself in the NY Times, stating that so far, the gains to the United States had outweighed the losses from trade (but that was not necessarily guaranteed in the future). The fact that the US has always been on the top of the “technology ladder'' guarantees that no dramatic changes can be expected in future, either.

As the first on the list of people that Samuelson criticized (with N.G. Mankiw, Alan Greenspan and Douglas Irwin being the other three), Jagdish Bhagwati acknowledged results from the Samuelson’s model. ''And in markets like information technology services, where America has a big advantage, it is true that if skills build up abroad, that narrows our competitive advantage and our exports will be hit.'' But in his book ''In Defense of Globalization'' (Oxford University Press, 2004), he doubts whether the Samuelson model applies broadly to the economy. ''Paul and I disagree only on the realistic aspects of this,'' he said.

Samuelson further polished his findings in his paper form December 2006, where his conclusions were that trade and globalization will likely benefit all regions, more to poor than to rich places, possibly exacerbating real income inequality between rich and poor, but certainly bringing more lifetime uncertainty along with augmenting material gains. Any slow down in freer trade, as economic history suggests, Samuelson repeated, would lead to “weaker productivity advance, enhanced degree of monopoly, and to aggravated crony-capitalism and plutocratic lobbyist democracy.” However, Samuelson already said that in his paper from 2004[27], and few trade union leaders or protectionist lobbyists would make a case this at all, had it not been followed by his statement that ''being able to purchase groceries 20 percent cheaper at Wal-Mart does not necessarily make up for the wage losses in the US.'' But it does make up, as shown in his own analysis from both recent articles.

A3. How many jobs has America lost so far

In a recent UNCTAD report, `Shift Towards Service', a prediction is given that almost 3.4 million service jobs are to be outsourced from the US till 2015. However, analysts claim that the situation is far from dramatic, since the same study estimates this figure as insignificant - when compared to the average turnover of four million jobs in US every month. However, most American media cut this last sentence from their report.

Until it became clear in mid 2005 that it was the recession that kept jobs rate at low level, globalisation and outsourcing were the first on the list of accused for low employment rates in the US. The fears that China would take away most of manufacturing and that India would take away the jobs in high-technology services started to dominate, and politicians started building their carriers on aiming to protect the US from harsh competition from the Far East. Graphs like Figure 1 presented here, predominated in US media, showing that over 3.5 million people lost jobs in manufacturing industry.

When observing a longer-run horizon, like we did in Table 1 and in Figure 2a, one can observe that aggregate employment in the US fell only in 2002, when two million jobs closed.

Employed and Unemployment Level in the US, 1970-2007

Numbers in thousands, 16 years and over

- Figure 2a number of employees - -Figure 2b: number of unemployed -

[pic]

But if principal causes of closing jobs in America were free foreign trade, imports from China and outsourcing, it would hardly be possible to have a net rise in employment of 1.7 million people only a year later (2003), and what more, that employment is growing at faster pace in 2005 and 2006 than it did in pre-recession period?

Table A.3.11 Employment and Annual Increments in Jobs in the US

|1998 |1999 |2000 |2001 |2002 |2003 |2004 |2005 |2006 |2007 | |Employed, 000 |130726 |133027 |136559 |137778 |135701 |137421 |138471 |140236 |143099 |145957 | |Annual change, 000 |+2428 |+2301 |+3532 |+1219 |-2077 |+1720 |+1050 |+1765 |+2863 |+2858 | |Source: U.S. Bureau of Labor Statistics

Employment in manufacturing industry is still falling and those developments need further explanation. Raising productivity in manufacturing industry indeed led to more layoffs than before.[28] Automation and computerization have reduced the number of man-hours needed to produce a ton of steel. This raised productivity enormously, but low-skilled jobs were automated and the jobs that remained required more education and training.

Another factor remains for massive present and future layoffs in steel industry, leading to further expected to decline 13 percent over the 2004-14 period, primarily stemming from increasing consolidation in the industry as companies are bought by other companies in the industry and their operations merge. As larger companies create more efficient mills, the result will be fewer workers, but a more productive industry that will be better able to meet foreign competition.

If it ever became clear in public that automation and mergers, rather than the Chinese, were the principal cause of layoffs in US manufacturing, the case of outsourcing was not that clear at all. The call-answer services and the reading of x-ray charts by Indian radiologists brought about fears that the US would “lose services also!”

But nothing is less truth. Bhagwati calls this process the “ladder of comparative advantage”, where innovation capacity guarantees to the rich countries to remain on the top of the ladder. In his famous book Free Trade Today, Bhagwati describes how poor countries, like Mauritius and Indonesia, started out entering foreign trade in exporting labor-intensive goods, such as toys and clothing. More advanced businesses, such as consumers electronics and automobiles, were taken by countries like South Korea and Taiwan. And rich nations, like the US and Japan, keep businesses which operate at the frontier of technology, and continuously create new industries like wireless communications and biotechnology. Ant it is this very hierarchy of production that helps reducing poverty in these poor nations. It is undeniably the fact that such a dramatic poverty reduction could not have taken place if countries like Thailand, Malaysia, and other Asian countries were not able to export their products to the developed world.

Bhawgati (2002) argues that the United States should not even try to keep hold of low-value businesses, such as insurance processing and telephonecall centers, even if its workers could operate them more efficiently than their counterparts in developing countries. Instead, businesses like publishing and entertainment should be focused one, hende this is where the displaced workers find more productive employment. According to the US Bureau of Labor Statistics, the copyright business, film, music, books, and IT businesses, account for about five per cent of the Gross Domestic Product, which means it is the biggest sector in the economy, bigger even than the auto industry. Demand for jobs in the US information technology constantly rises and the pay for these jobs is estimated to remain high and rise also. The US Bureau of Labour Statistics estimates are that the demand for computer-support specialists and software engineers is going to double between 2000 and 2010, while the demand for database administrators is expected to rise by three-fifths. Among the top score of jobs with the highest growth, half will need IT skills.

Still the fact remains that exports of services from the US vastly exceed their imports, which consists mainly of low-value services, while high-value services remain to be exportables. However, most American media do not frequently publish this fact, and the fear of losing jobs stil remains vivid. According to Bhagwati in his famous book Free Trade Today, the reason lies in different weights that people give to these news, as "…infinite weight" is accorded jobs lost to foreign competition, and the "zero weight" is accorded jobs created by trade”.

On the other hand, if one tries to impose restrictons to free trade, jobs might be saved, but cost of saving jobs can be very high. As shown in Blinder (1987) job saving in textile industry was tried by implementing import quotas on textile, but it succeeded only in raising consumers annual costs by $42,000 per saved job, which greatly exceeded the average earnings of a textile worker. That same study showed that each saved job in car industry costs $105,000, each job in TV manufacturing costed $420,000 and that the society paid even $750,000 for every job saved in the steel industry. The author challenged protectionists with the following offer to redundant workers: “we will give you severance pay of $750,000—not annually, but just once—in return for a promise never to seek work in a steel mill again. Can you imagine any worker turning the offer down? Is that not sufficient evidence that our present method of saving steelworkers' jobs is mad?” Recent estimates lead to similar conclusions. Clyde and Wada (1999), show that US households would have to pay over $800,000 per year in order to save jobs for only 1,700 workers in steel industry. The conclusion from all these studies is that by “draining” small amounts of money from many households, very few firms will be tremendously enriched.[29]

Technological progress is known to have destroyed more jobs than free trade and no efficient means of protection from technical progress have ever been invented. In the example of steel quotas, the study shows that quotas could do little to achieve their announced goals of job saving. Due to rising productivity output was constantly growing, but steel employment has been constantly falling as inefficient integrated mills were closed, whether or not steel quotas were imposed. Most of the “jackpot money” goes to lucky steel importers (windfall gains of $600 million) and efficient US steel firms (windfall gains of at least $200 million). In adition to being extremely costly, protection turns out to be no more than a short-run jobs-saving policy. But at the same time, ideas and movements aimed at job protection remained throughout history, from Ludist's movement to anti-globalisation and anti-outsourcing movements of today.

A.4. Will freer[30] trade reduce wages in rich countries

Fears remain in rich countries, and theory confirms that following the factor-equalisation-theorem, that freer trade with the poor countries is bound to creating poor in the rich countries, since the real wages of unskilled workers would fall. But probe deeper and the fear vanishes, as Bhagwati says in his Ludvig Erhard lecture (2004). The prerequisite for this outcome would have to be the falling (relative) prices of labour-intensive goods (such as textiles and shoes) in world trade. But evidences are that these prices constantly rise instead! This is so because a false general presumption was made - that over time more and more poor countries will enter in trade of these goods, which will lower their prices. But this is not the case. Poor countries do not join trade simultaneously, but one by one, so that some already withdraw from labour-intensive exports and only then new suppliers enter. When the famous Bhagwati’s “ladder of comparative advantage” is called for again, one can see that China’s actually stepped in exports sectors that East Asian economies already withdrew from; and the same thing happened to these countries, who entered those markets in the 1970s, when Japan started to shift away from them.

As shown in previous section, trade with poor countries cannot be accused for the downward pressure on rich-country wages in some sectors. Sapsford and Garikipati (2006) argue that when downward trend in sector wages is noticed, that it already indicates a mature industry, where tehnological changes will soon emerge, and that competition that comes from abroad at that moment actually moderates the fall provoqued by technical change that continually reduces the need for unskilled workers.

According to the trade theory, free trade brings to the poor three principal benefits: (1) foreign investment raises the marginal product of labor, resulting in a rise in wages, 1health and safety standards in a poor country (evidence can be traced in Table A.4.1)

Table A.4.1); [pic]

(2) opening the country enables migration to richer countries, resulting also in a rise in wages and remittances (3) according to Stolper-Samuelson proposition, export activities lead to higher real wages in export sector, and Balassa-Samuelson effect ensures us that workers in other sectors would benefit through the inevitable prcess of wage equalisation whithin the country.[31] This in fact leads to the conclusion that pro-poor impact of trade will be emphasised, because the real wages of the unskilled workers will inevitably rise.

-----------------------

[1] These gains are “static“, i.e. gains from the reallocation of existing resources (both in terms of gains in consumption and production), while “dynamic” gains stem from from raising productivity and increasing growth rate.

[2] A specialization should emerge in that good in which production costs across countries are relatively lowest. However, neither the monetary costs of production nor even the resource costs (labor per unit of output), but opportunity costs of producing goods across countries should be taken into account.

[3] Dixit (1984), Grossman (1996)

[4] Bhagwati’s (1982) terminology

[5] The two remaining international theory frameworks comprise the Heckscher-Ohlin framework and a framework with industry-specific and intersectorally mobile production factors. In all cases the imposition of trade restrictions can cause nothing but a net loss to society, as the losses from trade restrictions always remain larger than the gains from trade restrictions.

[6] Assuming identical tastes and technologies in a two country, two-commodity, two-factor framework

[7] With any number of goods and factors and with no restrictions on technology, protection of one good will lower income of some factor and raise that of another, provided that initially the protected good was domestically produced and that all inputs had alternative domestic employment opportunities. In addition, the time component appears. Protected production factors definitely gain in the short run, but their long-run gains depend on their adaptability to change sector, and production factors “stuck” in producing inferior goods lose in the long run..

[8] It was developed and formalized mathematically by Ronald Jones (1971) and Michael Mussa (1974).

[9] According to the Chairman of CEA in the first George Bush’s mandate, “… if you try to explain this fact to one of the Beltway mercantilists, the best response you can hope for is a polite, condescending smile, as he reflects on how naïve you are. More likely, he will act outraged and offended, and if you are a public official, he will call for your resignation. (Mankiw, 2006).

[10] The use of trade policies to alter the outcome of international competition in a country's favor, usually by allowing its firms to capture a larger share of industry profits.

[11] As described in Begovic (2005), the problem remains that substantial part of the monopoly profit (rent) dissipates in efforts to secure the monopoly position, i.e. quota-based import license.

[12] Retaliatory tariffs were threatened by 67 US senators who passed a resolution (sponsored by Charles Schumer and Lindsey Graham) declaring that a 27.5 percent tariff would be imposed on all Chinese imports if China failed to revalue it currency within six months. Strong opposition came from Alan Greenspan, Chairman of the Fed, on the grounds that this threatens global financial system and engangers the funding of US deficits. Senator Schumer accused the President Bush’s position on the yuan as having the “strength of a wet noodle”. At last, in July 2005, Chinese central bank revalued the yuan by 2,1 percent against the US dollar and announced that revaluation was just an “initial adjustment”. The exchange rate system is similar to Singapore’s managed “basket, band and crawl” model with currency floating within a pre-set policy band. The revaluation turned out to be “well below 40 percent revaluaton demanded by politicians and even the 10 percent increase that Henry Kissinger, former secretary of state, suggested that will be needed to calm down the US administration)”. Source: articles/2005/jul2005/yuan-j29.shtm.

[13] Sala-i-Martin (2006)

[14] This is the famous ‘Bhagwati hypothesis’. It is very well described in Bhagwati, 2004 and Sapsford, Garikipati (2006).

[15] Dollar, Kray 2001.

[16] Rodriguez and Rodrik (2000).

[17] Krueger (1993).

[18] Panagariya (2006).

[19] Lustig (1994) quotes a leading forecasting firm saying that “NAFTA will double both the growth rate of Mexico’s overall economy and the growth rate of its wages —specifically boosting the wage growth rate from 1.2 per cent to 2.4 per cent per annum”, which unfortunately never happened. ”. Burfisher et al. (2001) say that the studies of NAFTA using general equilibrium models all conclude that “NAFTA would benefit all three member countries [Mexico, the US and Canada], with the largest relative gains going to Mexico”, and they quote a pre-NAFTA survey which concluded that “the effects of NAFTA would be positive but small for the US economy, and positive and large for Mexico.” Pacheco-López, Thirlwall (2004)

[20] “Swedosclerosis” is described as a process of reducing economic growth trough generous welfare state policies. Nowadays economists even use the term “Eurosclerosis”.

[21] McCulloch and McPherson (1998), pp. 36

[22] Bhagwati, 2005.

[23] Bhagwati (2005) mentions three fallacies, we think that the list should be augmented by the first one listed in the text.

[24] The former US trade representative in the WTO, and the acting President of the World Bank Robert Zoellick, launched a plan of reduction of tariffs on non-agricultural products to a ceiling of 8% by 2010, then progressively cut to zero by 2015.

[25] Wealth of Nations, 1776

[26] According to Bhagwati (2006), globalization has at least five distinct aspects: trade, direct foreign investment (or what is sometimes simply called “multinationals”), short-term capita flows (which were at the heart of the Asian financial crisis in the 1990’s), international flows of humanity, and technology transfer (which includes the problem of patents and generics which has central importance for the poor countries).

[27] “It does not follow from my corrections and emendations that nations should or should not introduce selective protectionisms. Even where a genuine harm is dealt out by the roulette wheel of evolving comparative advantage in a world of free trade, what a democracy tries to do in self defense may often amount to gratuitously shooting itself in the foot.” Samuelson, 2004.

[28] Fastest job declines can be traced on the BLS web page .

[29] The study showed that US households pay $400,000 annually for every job saved by high tariffs on ceramic tiles, $500,000 annually for every job saved by dairy quotas, and $900,000 for every job saved by tariffs on luggage. Saving jobs by imposing trade barriers turns out to be a very costly way of doing it, the study shows.

[30] The word freer as distinct from the word free comes from Jagdish Bhagwati's work, highlighting his willingness to move outside the trade theory, and to enlarge analysis beyond direct comparison between autarky and totally free trade as extreme points of the spectrum, as distinct from seeing liberalisation “as the process of moving some way along this continuum.” This consideration becomes highgly relevant when moving from theoretical arguments towards empirical verification.

[31] . Numerous empirical studies appear to uphold the Stolper-Samuelson argument (e.g. Krueger, 1983; Beaulieu et al., 2001; Dollar and Kray, 2001, etc)

-----------------------

Box 5.2 One size fist all, after all?

Many authors, including Jozef Stiglitz, frequently complained that globalizers and freer trade advocates too much insist on a "one-size-fits all" approach taken to development, indicating how market reforms prevent countries to freely experiment with policies which would best suit their situations and needs.

…

It has now become fashionable, at least in certain international bureaucracies (e.g. the World Bank in its populist phase under former President Wolfensohn), to argue that we need policies that are not universal in prescription but which reflect the fact that “one [shoe] size does not fit all”. This is a silly cliché, I must say. Economics, like any science, looks for general prescriptions; else, it becomes a negation of any pretension to science. Thus, in deciding on policies, we have to decide whether we want to go barefoot or to wear shoes: in terms of trade, we have to decicde whether we want to push for freer trade or for protectionism. Once you have decided, for instance, to wear shoes, only a knave must think that the shoe size will not vary as we get down to specific countries. Bhagwati, Erhard Lecture, 2004.

Box 3.1 Why free trade fails to persuade?

The first to blame for poor persuasive power of the famous free trade argument of comparative advantages is a counter-intuitive nature of the argument itself! There is a well known anecdote of Nobel laureate Paul Samuelson, being challenged by the mathematician Stanislaw Ulam to name a proposition in all of the social sciences which is both true and non-trivial”, answered “Comparative advantage”.

“That it is logically true need not be argued before a mathematician; that it is not trivial is attested by the thousands of important and intelligent men who have never been able to grasp the doctrine for themselves or to believe it after it was explained to them.” Source: WTO

Box A.3.2. Will Indian radiologists lose jobs over Inidan competition?

“The scare for US-based radiologists (and extended to all medical professions almost instantly), created by radiologists in the Massachussetts General Hosiptal sending x-rays digitally to be read by a radiologist in India, turned out to be little more than a panicky one. Subsequent examination has shown that, to date, not one radiologist in the US has lost his job! Their earnings also remain extremely high, as does the demand for their services. Besides, the x-rays that now get read abroad typically go to India and Australia where the time zone difference enables these charts to be read by radiologists who work while the US-based radiologists sleep at night or rest over the weekend…”Indeed, even if jobs for radiologists were to decline, there would be new jobs coming up for obesity-treating doctors and related medical specialities and treatments (such as liposuction and diabetes) as the US experiences an obesity epidemic and for plastic surgeons as America also ages.”, as Bhagwati (2004) argues.

Box A.4.1 Will EU enlargement does not lower wages in Scotland

EU enlargement brought fears that lower skilled workers from new member states would make a pressure towards lowering of domestic wages in rich countries. Old member states take different positions on this matter, mainly keeping protectionism high. On the contrary, Scotland seems to reject this policy. As The Economist reports, East Europeans, especially Poles “have flocked to the Highlands since May 2004 to do the low-paid jobs Scots have turned their noses up at for years, in tourism, construction and food-processing.” Employers are doing everything they can to welcome them: producing vocabulary leaflets, providing English classes at the factory, learning Polish themselves, even offering accommodation.” … Experiences have been excellent so far, but employers fear that when more old EU members open their labour markets to workers from the new member states, that “the well of cheap, cheerful workers for Britain will dry up, since workers, with improved English, will head south for better-paid jobs. ” The Economst, Dec 13th 2006

Box 5.1 Who really negotiated in Cancun

Who insisted on removing agricultural subsidies …

… But I think it is mainly being driven by the interests of the middle-income developing countries, what I call the Cairns Group countries, which are Argentina, Brazil, Mexico, the Philippines, Thailand, New Zealand and Australia… the last two of them being “long frustrated by the inability to get rich-country agriculture liberalized, and have found it politically convenient to pretend that agricultural protection in the rich countries harms the poor nations of Africa.” (Bhagwati, 2005).

And who was against …(and those were not small European farmers) …

Contrary to the accepted wisdom that agricultural policy should protect small farmers … large sums of money are going into European agri-business and to the well-connected people. Alesina and Giavazzi (2006) state that “Prince Albert II of Monaco receives €300.000 a year for his farm in France, and the queen of England €546.000 (in 2003). The three largest beneficiaries or agricultural aid in Holand are the large companies Phillip Morris (€1.46 million in 2003), Royal Dutch Shell (€660.000) and Van Drie, and agri-business company (€745.000)… the same pattern occurs in Spain, Nestle in UK received €11.3 million in 2004... These are the only counties for which we could obtain data … but we suspect that similar sieable sums are paid out in France and Germany.“

Since the agricultural sector absorbs almost half of the EU budget, it is clear that no small farmers could ever win such a large share of the cake. But with so strong allies in agri-business, it is much clearer now why it is politically convenient to pretend that agricultural protection in Europe is actually helping to preserve the culture of small farming communities.

BOX A.3.1. Where have we won?

“All I hear from Washington is that trade is a win-win proposition. Then I look at our growing trade deficit and think about the 3,400 good people in our good factories that we had to let go and I want someone to show me where we have won." John Emrich, chief executive of Guilford Mills in Greensboro, N.C. The New York Times quotation of the day, 2 November ’04.

But estimates show that the society paid even $750,000 for every job saved in the steel industry. The author challenged protectionists with the following offer to redundant workers: “we will give you severance pay of $750,000—not annually, but just once—in return for a promise never to seek work in a steel mill again. Can you imagine any worker turning the offer down? Is that not sufficient evidence that our present method of saving steelworkers' jobs is mad?” Blinder (1987).

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